THIRD MODIFICATION AGREEMENT


         BY THIS  THIRD  MODIFICATION  AGREEMENT  (the  "Agreement"),  made  and
entered  into as of the 5th day of August,  1996,  WELLS  FARGO BANK OF ARIZONA,
NATIONAL ASSOCIATION,  formerly known as FIRST INTERSTATE BANK OF ARIZONA, N.A.,
whose address is Post Office Box 29742, Phoenix,  Arizona 85038-9742,  Corporate
Banking Division (hereinafter called "Lender"),  and THREE-FIVE SYSTEMS, INC., a
Delaware  corporation,  whose address is 1600 North Desert Drive, Tempe, Arizona
85281-1212  (hereinafter  called  "Borrower"),  in  consideration  of the mutual
covenants  herein  contained  and other  good and  valuable  consideration,  the
receipt and  sufficiency  of which is hereby  acknowledged,  hereby  confirm and
agree as follows:

SECTION 1. RECITALS.

         1.1 Borrower and Lender  entered into a Loan  Agreement  dated July 11,
1994 (the "Loan  Agreement"),  which  provided for a revolving line of credit by
Lender to Borrower in the amount of  $5,000,000.00  (the  "Revolving  Commitment
Amount") upon the terms and conditions  contained therein (the "Revolving Credit
Loan").

         1.2 The Loan was  evidenced by a Revolving  Promissory  Note dated July
11, 1994, executed by Borrower, payable to the order of Lender, in the principal
amount of $5,000,000.00 (the "Revolving Note").  (Hereinafter the Loan Agreement
and the Revolving Note are referred to as the "Loan Documents.")

         1.3 Lender and  Borrower  have  executed  and  delivered  previously  a
Modification  Agreement  dated  as of June 28,  1995  and a Second  Modification
Agreement dated as of ________________ (together, the "Modifications") modifying
the  terms of the Loan  Documents.  Hereinafter,  "Revolving  Note,"  and  "Loan
Agreement" shall mean such documents as modified in the Modifications.

         1.4  Borrower  and Lender  desire to modify the Loan  Documents  as set
forth herein.

         1.5 All undefined  capitalized terms used herein shall have the meaning
given them in the Loan Agreement.

SECTION 2. REVOLVING NOTE.

         As of the  date  hereof,  prior  to  the  effect  of the  modifications
contained  herein,  the outstanding  principal  balance of the Revolving Note is
$___________.

SECTION 3. LOAN AGREEMENT.

         3.1 The Loan Agreement is hereby amended as follows:

                  (a)  Section 7.4 of the Loan  Agreement  is amended to read as
         follows:
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                           Section  7.4  Declare  or pay any  cash  dividend  or
                  purchase any treasury stock greater than $8,000,000.00.

                  (b)  Section 7.8 of the Loan  Agreement  is amended to read as
         follows:

                           Section 7.8 Permit its  Tangible Net Worth to be: (a)
                  less than  $41,606,000.00 as of September 30, 1996; and (b) on
                  each subsequent  Quarterly End Date, less than  $41,606,000.00
                  plus  fifty  percent  (50%)  of the  aggregate  of  Borrower's
                  positive net income of each subsequent  quarterly period, with
                  no deduction for any quarterly period net loss.

                  (c) Section  7.12 of the Loan  Agreement is amended to read as
         follows:

                           Section 7.12 Permit the ratio of  Borrower's  Current
                  Assets to its  Current  Liabilities  at the end of any  fiscal
                  quarter  to be less than 2.0 to 1.0 with both  Current  Assets
                  and  Current   Liabilities   determined  in  accordance   with
                  generally accepted accounting principles,  except that Current
                  Liabilities  shall include all amounts  outstanding  under the
                  RLC  including  without  limitation  amounts  due and  payable
                  beyond a year.

SECTION 4. OTHER MODIFICATIONS, RATIFICATIONS AND AGREEMENTS.

         4.1 All  references  to the Loan  Agreement in the  Revolving  Note are
hereby amended to refer to the Loan Agreement as hereby amended.

         4.2  Borrower  acknowledges  that  the  indebtedness  evidenced  by the
Revolving Note is just and owing, that the balance thereof is correctly shown in
the  records of Lender as of the date  hereof,  and  Borrower  agrees to pay the
indebtedness  evidenced by the Revolving Note according to the terms thereof, as
herein modified.

         4.3 Borrower  hereby  reaffirms to Lender each of the  representations,
warranties, covenants and agreements of Borrower set forth in the Revolving Note
and the  Loan  Agreement,  with  the  same  force  and  effect  as if each  were
separately stated herein and made as of the date hereof.

         4.4 Borrower hereby ratifies, reaffirms,  acknowledges, and agrees that
the Revolving Note and the Loan  Agreement,  represent  valid,  enforceable  and
collectible  obligations  of  Borrower,  and that there are no existing  claims,
defenses,  personal or otherwise, or rights of setoff whatsoever with respect to
any of these documents or instruments.  In addition,  Borrower hereby  expressly
waives,  releases and absolutely and forever  discharges  Lender and its present
and former shareholders,  directors,  officers,  employees and agents, and their
separate and respective heirs, personal representatives, successors and assigns,
from any and all liabilities,  claims,  demands,  damages,  action and causes of
action,  whether  known or unknown  and  whether  contingent  or  matured,  that
Borrower  may now  have,  
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<PAGE>
or has had prior to the date hereof, or that may hereafter arise with respect to
acts,  omissions  or events  occurring  prior to the date  hereof  and,  without
limiting the generality of the foregoing, from any and all liabilities,  claims,
demands, damages, actions and causes of action, known or unknown,  contingent or
matured, arising out of, or in any way connected with, the RLC. Borrower further
acknowledges  and represents that no event has occurred and no condition  exists
that,  after notice or lapse of time, or both,  would constitute a default under
this Agreement, the Revolving Note or the Loan Agreement.

         4.5 All terms,  conditions and provisions of the Revolving Note and the
Loan  Agreement  are  continued  in full  force  and  effect  and  shall  remain
unaffected and unchanged  except as specifically  amended hereby.  The Revolving
Note  and the Loan  Agreement,  as  amended  hereby,  are  hereby  ratified  and
reaffirmed by Borrower, and Borrower specifically  acknowledges the validity and
enforceability thereof.

SECTION 5. GENERAL.

         5.1 This  Agreement  in no way acts as a release or  relinquishment  of
those  rights  securing  payment of the RLC.  Such  rights are hereby  ratified,
confirmed, renewed and extended by Borrower in all respects.

         5.2 The modifications contained herein shall not be binding upon Lender
until Lender shall have received all of the following:

                  (a) An  original  of  this  Agreement  fully  executed  by the
         Borrower.

                  (b)  Such  resolutions  or   authorizations   and  such  other
         documents  as Lender may  require  relating to the  existence  and good
         standing of the Borrower and the authority of any person executing this
         Agreement or other documents on behalf of the Borrower.

         5.3 Borrower shall execute and deliver such additional documents and do
such other acts as Lender may reasonably  require to fully  implement the intent
of this Agreement.

         5.4  Borrower  shall  pay all costs and  expenses,  including,  but not
limited  to,  reasonable  attorneys'  fees  incurred  by  Lender  in  connection
herewith,  whether or not all of the conditions described in Paragraph 5.2 above
are satisfied.  Lender, at its option,  but without any obligation to do so, may
advance funds to pay any such costs and expenses that are the  obligation of the
Borrower,  and all such funds  advanced  shall bear interest at the highest rate
provided in the Revolving Note and shall be due and payable upon demand.

         5.5 Notwithstanding anything to the contrary contained herein or in any
other  instrument  executed  by Borrower  or Lender,  or in any other  action or
conduct  undertaken  by  Borrower  or Lender on or before the date  hereof,  the
agreements,  covenants and provisions contained herein shall constitute the only
evidence of Lender's consent to modify the terms and provisions of the Revolving
Note or the Loan  Agreement.  Accordingly,  no express or implied consent to any
further  modifications  involving any of the matters set forth in this Agreement
or  otherwise  shall be  inferred  or  implied  by  Lender's  execution  of this
Agreement.  Further, Lender's execution of this Agreement shall not constitute a
waiver  (either  express  or  implied)  of  the  requirement  that  any  further
modification  of the RLC or of 
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<PAGE>
the Revolving  Note or the Loan  Agreement,  shall  require the express  written
approval of Lender;  no such approval (either express or implied) has been given
as of the date hereof.

         5.6 Time is hereby  declared to be of the essence hereof of the RLC, of
the Revolving Note and of the Loan Agreement,  and Lender requires, and Borrower
agrees to, strict performance of each and every covenant,  condition,  provision
and agreement hereof, of the Revolving Note and the Loan Agreement.

         5.7 This  Agreement  shall be  binding  upon,  and  shall  inure to the
benefit  of, the  parties  hereto  and their  heirs,  personal  representatives,
successors and assigns.

         5.8 This  Agreement is made for the sole  protection and benefit of the
parties  hereto,  and no other  person or entity  shall have any right of action
hereon.

         5.9 This Agreement shall be governed by and construed  according to the
laws of the State of Arizona.

         IN  WITNESS  WHEREOF,  these  presents  are  executed  as of  the  date
indicated above.


                                        WELLS FARGO BANK OF ARIZONA, NATIONAL
                                        ASSOCIATION, formerly known as FIRST
                                        INTERSTATE BANK OF ARIZONA, N.A.



                                        By:____________________________________
                                        Name:__________________________________
                                        Its:___________________________________

                                                                         LENDER


                                        THREE-FIVE SYSTEMS, INC., a Delaware
                                        corporation



                                        By:____________________________________
                                        Name:__________________________________
                                        Its:___________________________________

                                                                       BORROWER
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